Understanding Risk Management in Trading

[madmax]

Welcome everyone
In today’s post we will discuss how one can understand risk management in trading, and action it.

We will start off by defining what risk management is.

Risk management definition:
Risk management is the process of identifying your current capital and assessing what you can afford to invest and lose. Never to see again.
It involves identifying risks, assuming risks and ensuring you have a planned response for before, during and after a trade.

CAPITAL IN RISK MANAGEMENT:
In the past, I have stated that the goal of trading is to “PROTECT” your capital first. Once you know how to protect it, you can then multiply it and risk bit by bit.
To take on proper risk management, you must decide what amount you will allocate to your investments or trades. For example – you risk only 1% of your capital on every trade.

INVEST WHAT YOU CAN AFFORD TO LOSE:
You should only do trading with the funds that you can AFFORD to lose, even then you must be cautious and apply the process above to the same capital. Doing this eliminates the emotional pressure factor and avoids decisions that are driven by Fear of Missing Out. (FOMO)
Before Trading, set a clear number on what you can lose (NEVER to see again) without it affecting your life.

IDENTIFYING RISKS:
Relating to my previous posts, you must have a defined trading plan/edge. This plan must allow you to identify market volatility, news events, psychological mistakes, or technical invalidation points. These are risks that must be identified BEFORE trading.
Knowing these will allow you to apply the right position size correctly.

ASSUMING RISKS:
When it comes to assuming risks, (most people don’t factor this in) it means to accept the potential scenario of you losing, before the trade is actioned.
Your stop loss (always use a stoploss!) must be defined in a way that will not get yourself liquidated. You must calculate the right position size and learn to accept the outcome of the trade, and the mental effects it has on you.
Doing this, the trades & the process becomes mechanical. No longer would it be emotional.
If the loss is too big and you take it anyway. You should not be taking that trade as it will encourage revenge trading.

PLANNING RESPONSES BEFORE, DURING and AFTER RISKS:
With trading & risk management, you must have a pre-defined response for before, during and after trades. Your risks must be set.

Before the trade, you should have an entry, SL & TP set. Along with an invalidation level (if price hits a specific point, you DON’T take the trade) and a maximum risk, eg “I’ll risk max $5,000 on this trade”

During the trade, you must stick to the plan, don’t adjust your SL, or TP if it’s not part of your strategy.

After the trade, if you win, or lose, find out why. Was it a valid trade, did it follow your edge? Or did you take a blind gamble. If you lose, figure out why, if you won, figure out how you could have scaled it upwards.

Applying these 3 factors allows the cycle of discipline to develop and grow. It then removes randomized decision making.

Risk management is a crucial Key in trading. Without it – you have already lost.
I have attached the 3 KEYS to trading success below. Here I go in depth on what an individual must master to be successful in trading.

[Rimon Khan]

Proper risk management is the real edge—most traders learn it only after losing.

[alex10]

Master risk first, profits come later. This topic is always underrated.

[EmTeam]

, I have stated that the goal of trading is to “PROTECT” your capital first. Once you know how to protect it, you can then multiply it and risk bit by bit.